Bloomberg Says Quants Aren’t Adding Up. I Say Bull - If They’re Legit

On 1/19/19, Bloomberg published an article by Satyajit Das likening quantitative asset managers to “alchemists seeking to transform base metals into gold” based on “pattern recognition” (correlating “past periods of superior return with specific factors”) but being foiled by “hindsight bias” and “practical matters, such as what data is or isn’t available.” Yes, there are quants who work that way. But by defining quant investing based on their activities is akin to defining medicine in terms of those who thought application of leeches to bleed patients was the pinnacle of medical practice. (By the way, when searching for stock photos, I actually found a bunch that suggest there are folks — healers — today who still do this. Eeew!)

Can Stock Photo, Ollyy

Who Is A Quantitative Investor?

Sadly, at present, a quantitative investor is anyone who claims he or she is one, especially if one can lay claim to any one of a number of certifications now available in today’s credential-obsessed world.

But self-pronouncements, job descriptions, degrees, certificates, etc. do not and cannot make one a quantitative investor. The only way to legitimately achieve that stature is to do the following:

  1. Be an Investor
  2. Apply Quantitative Processes to investing

Countless practitioners meet criteria #2. The ones who deserve the critique offered by Bloomberg are those who are not, and often don’t even try to fulfill criteria #1, to be investors.

Who Is A False Quant

Bloomberg got it right when it panned the practice it refers to as pattern recognition (for what it’s worth, I prefer such labels as data mining, curve fitting, or naive extrapolation). It’s incredibly widely practiced and even revered; see., e.g., the work of Eugene Fama and Kenneth French

Wait a minute! Aren’t those the guys who wrote so much about Value, Company Size, Quality, the impact of the Market? Isn’t that stuff real? That doesn’t sound like the work of quacks.

Such factors are, indeed, very much real. But if one merely demonstrates that they are real without understanding WHY they are real, well, that’ not a real quant. That’s merely evidence in support of the proposition that it can be better to be lucky than good.

(Am I unjustifiably lumping Fama and French in with the bad apples? Maybe. I never met them. But I did see a paper they produced dismissing Dividend Yield as a factor that badly turned me off. How could they even have bothered to look into such an obviously absurd hypothesis! Any competent investor knows, without having to stage a big research project, that higher yields exist because share prices are bid down — relative to the level of dividends — due to investor fears that the dividend will be reduced or eliminated, typically due to expected poor company performance. The more reasonable topic for research is whether lower yield (down to and including zero) is the factor to be positively associated with future equity returns given the presumption that low- and zero-yield companies tend to reinvest profits aiming at internally generated growth.)

Who Is A Bona Fide Quant; A Quant Investor?

A bona fide quant is one who acts upon the least quoted but perhaps most poignant passage in James O’Shaughnessy’s What Works on Wall Street: “If there is no sound theoretical, economic, or intuitive, common sense reason for the relationship, it’s most likely a chance occurrence.” Wall Street veteran Marc Chaikin puts it another way: Does it pass “the smell test?” A legitimate quant, upon viewing a test result that seems contrary to rational financial expectations, first reviews the way the variable has been articulated to look for the error(s), and if there are no errors, to look hard for logical explanations.

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